Blue City Investments 1: Apartment therapy

Middle Eastern governments have long maintained that their economies must diversify away from a dependence on the sale of crude petroleum products. Some have had more success than others, and Dubai, Doha and Abu Dhabi are all the subjects of ambitious building programmes and strenuous efforts to develop tourism. Oman, a slightly sleepier corner of the Gulf, with slightly smaller oil reserves, is the latest country to attempt a large scale real estate development from scratch.

The deal is notable first of all as an international bond financing for Gulf real estate, which has to date benefited from strong local and regional bank market liquidity and well-capitalised sponsors. The $925 million financing also uses tranching, insurance from a multiline provider, and structural techniques common in whole business securitisation to finance a speculative project in a region where construction is buoyant.

The sponsors of Blue City are Ahmed Abubaker Janahi, through his holding company AAJ Holdings (70%), and Cyclone LLC (30%), whose shareholders are His Royal Highness Sayyid Haitham bin Tariq al Said, also Oman's culture and heritage minister, and Anees Issa 5767 Mohamed al Zadjali, a local businessman. Janahi is based in Bahrain, and several of his businesses have experience in designing, developing, and managing such projects.

The bond financing is divided into several tranches: a 2013 A1/A2 tranche of $399 million, insured by Axis Specialty, a $262.5 million A3/A4 tranche due 2016 and rated BBB- (Fitch), a $143 million, BB-rated B1/B2 tranche due 2016, and BB-rated C and D tranches of $50.5 million and $70 million, respectively, both of which are also due 2016. The lead arranger of the bonds was Bear Stearns, while joint managers were Credit Suisse, Standard Chartered and SHUAA Capital.

The project sits on up to 34km2 of land, and will draw in a 250,000-strong permanent and visiting population by 2030. The first phase will consist of 5,000 residential units, both apartments and villas, and sales of these units are at the core of the transaction's credit. While the additional developments, including the hotels, will be available to bond holders as collateral, the deal is more about cashflows than recovery values.

The proceeds of the bond issue will largely be kept in escrow or used to fund debt service reserve accounts, of which the bonds have several. A full $584.9 million will be held in this fashion, and of this a further $105.4 million will be drawn over the next 15 months to fund construction. Bank of New York is issuer note and security trustee, and is also the project's offshore security trustee. It is also providing cash management services. The sponsor might have looked to a staggered issue to deal with some of the inefficiencies associated with so much unused cash, but the additional complexity would have added to an already highly structured deal.

The offshore issuer lends on the proceeds of the issue to Blue City Company 1, which shares ownership, though through different intermediate companies. But this borrower lends much of that – roughly $410 million – back to the issuer, to fund a special reserve account, senior debt service reserve account, second senior debt service reserve account, junior debt service reserve account, partial credit guarantee account, and an insurance premium reserve account. These funds are applied if necessary, and in a strict waterfall structure, to the various classes of notes.

The A1/A2 tranche features a credit insurance policy from A-rated (S&P) Axis Specialty, a Bermuda-based insurer. The tranche is not rated by Fitch, unlike the note's other classes, and the insurance policy falls something below the unconditional and irrevocable monoline policy. Fitch does note that the credit quality of the notes is at least equal to the BBB- A3/A4 tranche, and that the policy has a clear submission process, a pay-now-litigate-later claims structure, and limits on the insurer's defences. This last is a reference to some instances in which multiline insurers have failed to make good on claims in connection with structured financings.

Ultimately, however, the success of the transaction will come down to the interest in regional and domestic travelers to visit and buy homes at the development. Oman has a reputation as a quieter, less ostentatious corner of the gulf region, with an imprint from British rule more pronounced than many of its neighbours. It also benefits from more varied scenery than other GCC states, and an investment climate that now allows 100% foreign non-GCC ownership of properties within designated areas, and 100% GCC national ownership of property anywhere in Oman.

The development should benefit from the growing numbers of Omanis looking for suitable investments within the country, and who are willing to repatriate petrodollars invested in the US and Europe. However, European retirees and expatriate management, as well as South Asians and GCC nationals, will all have properties suitable to their needs. Hamptons, the consultants retained to assess the country's real estate market, has suggested that while Dubai is not a useful comparison, or competitor, it might create some spillover demand that Blue City would be well placed to exploit.

The contractor for the first phase is a joint venture of Turkey's ENKA and Greece's AKTOR, which are providing joint and several guarantees for a guaranteed maximum price contract. The maximum is roughly $1.866 billion, with the appropriate penalties and incentives for the project to come in on time and on, or under, budget.

The arranger came to market with the deal just as Israel invaded Lebanon in July 2006. The lead arranger duly postponed the sale until November. The delay may have helped the arranger to tranche the deal more effectively – with the senior debt split into covered and uncovered tranches, and the sub debt structured to sell to a small number of investors. The A1 priced at 160bp over the comparable treasury, about in line with expectations, but the A3 came in at 380bp, around 80bp over the most optimistic price talk.

Nevertheless, the financing met the chief objective of the sponsors and lead arranger – of achieving as wide a distribution as possible – and serves as a possible template for later big-ticket tourism projects in Gulf. Such projects will hope to be luckier in their timing, but the scale of the project, and the intricacy of the structuring, could spark follow-ups.

Blue City Investments 1
Status: Closed November 2006
Size: $2 billion (construction cost)
Location: Oman
Description: Financing for phase 1 of large residential and tourism-related complex
Sponsors: AAJ Holdings, Cyclone LLC
Debt: $925 million
Lead arranger: Bear Stearns
Joint managers: Credit Suisse, Standard Chartered and SHUAA Capital.
Sponsor financial adviser: Oppenheimer Investments
Note trustee, security trustee and account bank: Bank of New York
Onshore security agent and onshore account bank: Bank Muscat
Credit insurer: AXIS
Owner's engineer: Associated Consulting Engineers
Owner's project manager: Bovis Lend Lease
Borrower's technical adviser: Hill International
Borrower's insurance adviser: Willis International
Valuer: CB Richard Ellis
Sales agent: Hamptons International & Partners
Hotel consultant: HVS International
Model consultant: PwC
Construction contractors: ENKA and AKTOR
Sponsor and borrower legal: Clifford Chance (international) Trowers & Hamlins (Oman)
Underwriter legal: Shearman & Sterling (international) Al Alawi, Mansoor Jamal (Oman)
Trustee legal: Allen & Overy